Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
As you know, the Monetary Committee decided today to keep the interest rate at 0.1 percent, and reiterated that it intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range. In recent weeks, the Committee has discussed the interpretation of entrenchment of inflation within the target range, and I will elaborate on that in my remarks.
The picture of the state of the economy that was discussed during the course of the monetary discussions held by the Committee over the past two days is only slightly different than what was portrayed in recent months: a slight moderation in the economy’s growth rate is apparent, but it is still a solid pace that is in line with the potential growth rate, and there is a tight labor market in a full employment environment. The inflation environment continued to increase, and is approaching the target; the global economic picture remains positive, but it appears that the growth is losing some of its momentum. I will now elaborate on the various developments and their expected impacts on monetary policy in Israel.
The inflation environment continues to increase. The factors remain the same as those we have seen in previous months: first and foremost, wages in the economy continue to increase, and are acting to increase inflation. So long as the appreciation of the shekel and a decline in the prices of other inputs continued, they offset the impact on inflation of a rise in wages. However, in recent months oil prices have been rising, and the appreciation that was one of the main factors in the negative inflation rate halted. In addition, the moderate but continued increase in inflation worldwide also contributed to the stopping of the decline in tradable goods prices. In contrast, the enhancement of competition continues to moderate the pace of price increases, as do the price reductions initiated by the government, whether directly or by creating the conditions for price decreases.
The increase in actual inflation impacted on the expectations and forecasts as well. In particular, in recent weeks it appears that the rise in the inflation environment was internalized, and expectations for short terms rose sharply. Based on the forecasts and expectations from the various sources, in the coming months inflation as measured over the preceding 12 months is expected to enter the target range defined as price stability for the first time in about 4 years. The precise timing is to some extent a technical outcome of the low CPI readings of last year exiting the calculation, but the increase itself in inflation is not technical, but rather the outcome of the economic factors that I described. With that, a reversal of the trend in oil prices, or a renewal of the appreciation, should they occur, are a risk to the forecasts of inflation and will delay its return to the target range. The accommodative monetary policy makes a marked contribution to the process of returning the inflation rate to the target: the policy supports activity and demand, and against the background of the interest rate increase in the US, the policy in Israel contributed to the halt of the appreciation.
Economic activity continues to expand at an adequate pace, supported by the accommodative monetary and fiscal policies, as seen in preliminary data from the Companies Survey, and in the Bank of Israel’s analysis of the Business Tendency Survey conducted by the Central Bureau of Statistics. The first quarter growth rate was relatively high, partly due to enhanced imports of vehicles. These are expected to decline in the second quarter and lead to some slowing in the growth rate then. The expectation of some slowing in the second quarter is also an expected result of the economy approaching its potential output, and not being able to grow for a prolonged period of time at a rate higher than its potential. As for exports, growth of services exports is apparently continuing, but in recent months a renewed moderation in the growth rate of goods exports has become apparent. A marked and continued slowing is apparent in residential construction investment, and to the extent that it continues, it is likely to impact on activity at the aggregate level as well. The construction industry is also almost the only one for which labor market data are mixed: there was a decline in the job vacancy rate and in the growth rate of employee posts, but wages continue to increase as does the difficulty in recruiting employees reported by the firms; it is likely that these reflect a relative shortage of skilled workers. In most other industries, the data from the labor market continue to be positive—demand for workers is high, wages are increasing (particularly in the business sector), and the difficulty in recruiting workers, as well as the stability of the labor force participation rate at a high level, indicate that the supply constraint is serving as an effective limitation on continued expansion.
Since home prices reached a record high, they have declined by a cumulative 2.4 percent. Apparently the decline in the number of transactions halted, and some increase in new mortgage volume is apparent over the past year, after the prolonged decline in the preceding two years. On the supply side, the sharp and prolonged decline in the number of building starts is worrying, and it is important that the government continues to act to increase the housing supply. I note that the analysis of housing market developments is incomplete, because the publication of the data series on stock of new homes for sale, which was stopped in October 2016 due to a problem in the quality of the data, has not yet been completely renewed, and this data is required in order to assess whether the decline in building starts reflects a response to a decline in demand, or supply side problems.
The picture of the global economy remains positive, but it appears that momentum has weakened. In particular, the growth rate of world trade, which picked up in the past two years, has slowed in recent months, and the concern of the trade wars intensifying is weighing on the continued growth, and apparently on investments as well. The US economy continues to display resilience, but data from the other major economies were not as good. Emerging markets, particularly those whose macroeconomic fundamentals are relatively weak, are at risk due to the tightening of financial conditions. In addition, a possible heightening of political risks, particularly in Europe, and in the geopolitical tension in various areas around the world, can increase the risk to continued growth. Inflation in most economies continues to increase, and monetary policy is responding accordingly, but gradually and cautiously: in the US, where inflation is already entrenched, the interest rate increase continues, but in Europe the ECB announced a planned outline for reducing the quantitative easing and ending it only at the end of 2018, and in Japan the policy remained very accommodative. The relative weakness is reflected in capital markets as well, particularly those of emerging markets.
For over a year, the effective exchange rate has been relatively stable, and in recent months there has been a depreciation against the dollar; some of it reflects a strengthening of the dollar worldwide, due to the US economy’s robustness and the Fed’s continued interest rate increase. As monetary policy in Israel remained accommodative, the interest rate gap contributed to a weakening of the shekel, which contributed to an increase in inflation, and apparently to expected inflation as well. Other currencies also weakening against the dollar led to the depreciation in terms of the effective exchange rate being more moderate in that period, so that at the current level the exchange rate remains appreciated. The Bank of Israel was not required to intervene in the foreign exchange market in recent months, except within the framework of the pre-announced plan of foreign exchange purchases intended to offset the impact of natural gas production on the exchange rate. Should there be irregular fluctuations that are not in line with economic fundamentals, the Bank of Israel will not hesitate to purchase foreign exchange to moderate those fluctuations.
The Research Department presented its macroeconomic staff forecast to the Monetary Committee, and published it today. Recall that it is a conditional forecast based on assumptions regarding the exogenous variables, and in particular, the forecast is based on the assumption that the exchange rate and oil prices will remain stable. The forecast is similar to that compiled by the Department 3 months ago: the growth forecast for 2018 was revised upward, mainly as a result of the relatively high growth in the first quarter, and GDP is expected to grow by 3.7 percent. The growth forecast for 2019 remained at 3.5 percent. The inflation path in the forecast is slightly higher than that in the previous forecast, primarily as a result of the increase in energy prices, and after inflation enters the target range in the coming quarter it is expected to continue to increase very moderately toward the midpoint of the target; at the end of 2018 the Department assesses that the inflation rate will be 1.2 percent, and in a year it will be 1.4 percent. The interest rate path in the forecast did not change, and it is important to reiterate that it is a path that the Department forecasts, which is dependent on the development of other variables, and it is obviously not a commitment by the Monetary Committee. In addition, I again emphasize that it is important to pay attention to the fan charts that describe the broad range of uncertainty that characterizes the forecast for the various variables.
As I noted in my opening comments, the Monetary Committee again noted that it intends to maintain the accommodative policy as long as necessary in order to entrench the inflation environment within the target range. In the previous press briefing, I noted that in the Committee’s view, an analysis of the inflation environment requires an examination of the combination of actual inflation—emphasizing indices of inflation net of various one-off effects—and short-term inflation expectations. While actual inflation over the preceding 12 months remains below the target, it is expected to enter the target range over the coming months, and according to most forecasts and expectations, it is expected to be slightly above the lower bound of the target range in the coming year. In view of that, in the past weeks the Committee has conducted discussions regarding the meaning of the “entrenchment” of the inflation rate within the target range. The discussions led to two main points: the first is that the inflation target is 1–3 percent, as is known, and when the Committee talks of entrenchment it is not referring to the inflation rate being precisely at the midpoint of the range. However, as inflation tends to be volatile, a situation in which the expected inflation environment is very close to the lower bound of the target is not the entrenchment of inflation within the target range. The second point is that in order to establish that the inflation environment has become entrenched in the target, the Committee will want to be certain, to the extent possible, that the return of inflation to the target range will not last for only a few months. We will therefore need to wait and see how the inflation environment develops before we will be able to establish that it is entrenched within the target. In the meantime, the accommodative monetary policy will continue to support the increase in the inflation rate to within the target range defined as price stability. Remember that increasing the interest rate before the inflation rate is entrenched is liable to delay the entrenchment of the inflation rate in the target and ultimately to slow the path of an increase in the interest rate as well.